Facebook, Zynga, and buyer-supplier hold up

The brewing fight between Facebook and Zynga is what is known in economic strategy circles as "buyer-supplier hold up." The classic framework for analyzing a firm's strategic position is Michael Porter's Five Forces. In Porter's framework, Zynga's strategic weakness is extreme supplier concentration - they get almost all their traffic from Facebook.

It is in Facebook's economic interest to extract most of Zynga's profits, leaving them just enough to keep investing in games and advertising. Last year's reduced notification change seemed like one move in this direction as it forced game makers to buy more ads instead of getting traffic organically. This probably hurt Zynga's profitability but also helped them fend off less well-capitalized rivals. Facebook could also hold up Zynga by entering the games business itself, but this seemed unlikely since thus far Facebook has kept its features limited to things that are "utility like."

The way Facebook now seems to be holding up Zynga - requiring Zynga to use their payments system - is particularly clever. First, payments are still very much a "utility like" feature, and arguably one that benefits the platform, so it doesn't come across as flagrant hold up. It is also clever because - assuming Facebook has insight into Zynga's profitability - Facebook can charge whatever percentage gets them an optimal share of Zynga's profits.

The risk for Zynga is obvious — if they don't diversify their traffic sources very soon, they are left with a choice between losing profits and losing their entire business. But there is a risk for Facebook as well. If buyers of traffic (e.g. app makers) fear future hold up, they are less likely to make investments in the platform. The biggest mistake platforms make isn't charging fees (Facebook) or competing with complements (Twitter), it's being inconsistent. Apple also charges 30% fees but they've been mostly consistent about it. App makers feel comfortable investing in the Apple platform and even having most of their business depend on them in a way they don't on Facebook or Twitter.